Trader’s Narrative

Isn’t gold supposed to be a haven in times of stress? you know, real money? What happened then? why didn’t gold skyrocket to $2000 oz.? if it isn’t going to go up when the world’s financial market is in meltdown, when is it going to go up? The answer deduced from market history is that gold’s role as a safe haven is simply a myth.

It speaks to gold’s weakness in this market that it bucked the seasonality trend that I pointed out for the month of September. The AMEX Gold Bugs Index (HUI) - the only index which is comprised of only gold stocks - started and ended September at pretty much the same level.

My favourite indicator to time the gold market is the k-ratio. To understand how, check out the previous link. Here is a long term chart:

The k-ratio held almost constant, treading sideways for five years as both the numerator, gold stocks, and the denominator, gold prices, kept pace with each other. Because I was using this indicator to time the gold market, I lost some money because I didn’t see a fundamentally attractive opportunity at those prices. While it was painful to watch this historically reliable indicator, it has once again proven its merit. This is probably what people went through when it continued going lower and lower in the late 1990’s and 2000.

So what accounts for the collapse of the k-ratio? While gold has fallen around 4% for the year so far, gold stocks have fallen almost 50%! Believe it or not, that’s actually more than the equity market (S&P 500 Index). A large part of this is probably due to the forced liquidation that we witnessed in the markets last week.

Ironically, now that gold equity prices have fallen this much, the k-ratio is at levels last seen in late 1998 to 2002 - when the gold price was ~$250! The current gold price is more than 3 times that.

The AMEX Gold Bugs Index (HUI) has strong support at 175, which would mean the k-ratio to the low 0.20’s and once again, it could set up as a buying opportunity. I really don’t think we’ll revisit the lows that the k-ratio set in 2000 because that was due to a huge asset dislocation (thanks to Greenspan’s bubble).

While most people’s attention has been focused on the equity market turmoil, something interesting has played out in the gold market that bears to be highlighted.

It is a myth that gold acts as any kind of a safehaven but what we have seen isn’t the normal, run of the mill bull market correction. This one has been caused by the dislocation in the fixed income market.

Just today, gold closed at $658, down almost $22. Since the equity market top, it has fallen from a high of $700.

I’m sure all gold bugs are asking themselves: if gold can’t rally in the face of an equity market meltdown, the US dollar in the dumps, a credit crunch which has people dumping aything risky, and which has brought out a slew of negative headlines… when will it rally? When it is all sunshine and lollipops?

This gold bull market is over. Finished. Kaput. Sayonara. Ciao.

Le Caffe O’Lait
Of course, the folks at Le Metropole will rehash the usual conspiracy theories about central banks, the gold cabal, the plunge protection team, etc.

None of that matters.

By the way, isn’t it amusing that those that vehemently believe in and argue for the existence of this powerful, pervasive conspiracy also bet against it? Wouldn’t it be more congruent to plunk down everything you own in the market?

After all, if you believe that the plunge protection team and the Fed and all the other goblins and gouls out there in the shadows will rescue the market from a meltdown, why would you invest in gold? Why not go for the ride and make hay while the sunshines?

Bounce?
In any case, ironically, right about here I think gold stocks are ripe for an oversold bounce. Nothing fancy, just a tradeable rally.

Within the Gold Bugs Index (HUI) zero gold stocks closed above their 10 day and 50 day moving average. And only 7% closed above their 200 day moving average. Wouldn’t it be hilarious if gold stocks rallied along with the stock market?

Deep down inside the really hardcore gold bugs want the stock market to crash, gold to go to $3000 (or more) and maybe even have the Fed abolished.

While I do sympathize with their last fantasy, the reality is that even if the stock market does “crash” as they wish, rather than zoom higher, gold and gold stocks will probably fall as well.

I have no idea how this myth was perpetrated but most people believe that gold and gold stocks are the mirror opposite of the stock market. That one loses when the other wins.

Nothing could be further from the truth. History shows that whenever we’ve had a stock market crash, gold has never been a safehaven.

That is to say you would have lost money even if you sold stocks and bought gold ahead of time in anticipation or perfect fore-knowledge of the crash.

Although the recent market swoon is not even approaching “crash” levels, it is a good example of this:

In the chart, the Gold Bugs Index (HUI) is the candlesticks with the axis on the right. And the S&P 500 (SPX) is the line in the chart with the axis on the left.

If you don’t believe me, go back to any stock market crash and see for yourself. And if you’re still a gold bug, it may be time to face reality and accept that our recent gold bull market is over.